Instead, investors should look at six macro factors that research shows are responsible for the bulk of all profits made on assets, be they bonds or equities, according to Expected Returns 2018-2022.

The Macro Risk Factor Approach

This question of where returns really come from has led to the development of a new model in dynamic asset allocation: the Macro Risk Factor Approach. Instead of looking at assets as independent categories with their own unique return drivers – where bonds are from Venus and equities are from Mars – it looks at the common factors underlying all of them.

“Of course, given the noisy character of financial markets, it is almost impossible to fully explain the returns of every asset class by examining just a limited number of underlying drivers,” says Lukas Daalder, Chief Investment Officer of Robeco Investment Solutions.

“But research carried out by Robeco and others shows that six factors explain, on average, 80% of the returns of the various asset classes. They are intuitively easy to understand, hold up under the scrutiny of our statistical analyses, and are a valuable additional tool in explaining the composition of the underlying returns.”

Two groups of factors

Daalder says the six factors can be divided into three that are linked to the wider economy, and three to the ‘animal spirits’ that are an integral part of financial markets, and thereby to unexpected changes in risk premiums. The three pure macro factors are changes in real interest rates and inflation, which particularly affect bonds, and economic growth, which is more important for equities.

Three less tangible factors are linked to the ‘fear and greed’ element of markets. These are credit risks, which is associated with bond spreads and default risks; equity risks, often caused by what Alan Greenspan once famously called “irrational exuberance”; and emerging markets risks, which carry political risk from instability.

“Based on these six factors, we can now explain between 75% and 90% of the variability of returns in most broader asset classes,” says Daalder. “In other words, we can now say that we have a pretty good idea where most of the returns come from.”

Dissecting a portfolio

So how would this work at a portfolio level? Rather than just seeing the individual assets, we now get a better understanding of the ‘true’ risks underlying any portfolio,” says Daalder, who co-manages a multi-asset fund.

“This has a couple of advantages. By dissecting the investment portfolio into various macro factors, one can test whether it reflects the asset owner’s underlying growth and inflation assumptions. In other words, the Macro Risk Factor Approach provides a reality check on whether the portfolio’s current positioning is in line with the macroeconomic expectations of the asset manager.”

“Secondly, traditional portfolios may look well diversified, when in fact the assets they contain may be exposed to the same underlying macro risk factor. Investing in other asset classes rather than the common combination of 60/40 stocks and bonds can reduce sensitivity to the equity factor.”

“So, by looking at factors rather than asset classes, the traditional bonds-are-from-Venus-and-equities-are-from-Mars way of looking at the world becomes less appealing. The Macro Risk Factor Approach is a relatively new, but promising development in the field of multi-asset investing.”

This article is a summary of one of the five special topics in our new five-year outlook.

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The contents of this document have not been reviewed by the Securities and Futures Commission ("SFC") in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. This document has been distributed by Robeco Hong Kong Limited (‘Robeco’). Robeco is regulated by the SFC in Hong Kong. This document has been prepared on a confidential basis solely for the recipient and is for information purposes only. Any reproduction or distribution of this documentation, in whole or in part, or the disclosure of its contents, without the prior written consent of Robeco, is prohibited. By accepting this documentation, the recipient agrees to the foregoing This document is intended to provide the reader with information on Robeco’s specific capabilities, but does not constitute a recommendation to buy or sell certain securities or investment products. Investment decisions should only be based on the relevant prospectus and on thorough financial, fiscal and legal advice. Please refer to the relevant offering documents for details including the risk factors before making any investment decisions. The contents of this document are based upon sources of information believed to be reliable. This document is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. Investment Involves risks. Historical returns are provided for illustrative purposes only and do not necessarily reflect Robeco’s expectations for the future. The value of your investments may fluctuate. Past performance is no indication of current or future performance.

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